Reframing the Debate on Corporate Social Responsibility

The question of whether businesses can both do well and do good is an old one, and Edward Glaeser (Harvard) offers his own views on the debate in the New York Times today. Glaeser admits that his own thinking is fundamentally aligned with that of Milton Friedman, who argued that corporations’ only obligation is to maximize shareholder wealth, but he also wants to offer an alternative:

“I certainly agree with Friedman that traditional corporations have one overriding moral obligation — to fulfill their fiduciary duties and maximize shareholder wealth. Yet I’m also a fan of organizational innovation, which makes me a little more enthusiastic about the idea of experimenting with new legal entities with more complex objectives.”

Too bad Glaeser doesn’t go into enough detail for my liking and really spell out what these hybrid entities are and how they might reconcile what seems like an irreconciliable difference between doing well and doing good.

But then again, this debate always comes down to stalemates like this one, with neither side giving much ground to the other. I’m personally tired of this debate, and tonight, I aim to propose a rough sketch of an alternative.

And it goes like this: corporations can, in fact, both do well and do good, BUT, and this is the crux of my argument, it can only achieve both ends if its shareholders and the public actively provides a meaningful financial incentive for corporations to act in a socially responsible way.

An example. Two corporations A and B both make similar product X. However, corporation A makes product X in a country with laws that prohibits excessive environmental pollution when making product X. Corporation B, on the other hand, makes product X in a different country in which no environmental law exists. Suppose that in following the law, as every corporation is obligated to do, corporation A must invest in brand new production equipment and pay a huge upfront fixed cost, it has a distinct competitive disadvantage compared to corporation B, who because of its location, faces no such costs. Corporation A passes on this upfront fixed cost to the consumers, making its product X more expensive than corporation B’s.

Clearly, this example is simplified for the sake of argument: corporation A acted in a socially responsible way by obeying the laws of its country while preserving the planet for future generations. Corporation A could have moved to another country with less restrictive environmental laws and avoided the additional cost and remained competitively equal with corporation B, but it chose to do the right thing.

But what would the real-world result be for corporation A? First, consumers will probably stop purchasing its brand of product X and instead give their money to corporation B (assuming that only two corporations make product X). Shareholders of corporation A will probably sell off its stocks because corporation B is now clearly more profitable. The Board of Directors will probably vote out existing management and hope to find new management that will make corporation A competitive with corporation B again. This would most likely mean that the new management will move production of X to a different country with a much more lax environmental law.

In the end, the only loser in this hypothetical scenario is the environment and future generations who must live with a more depleted and more polluted planet.

So what is the essential problem: prisoner’s dilemma. How to resolve this problem: by creating totally different incentive structures so that corporations are not punished, but instead rewarded, for doing the sociall responsible/ethical thing. If the public is truly, sincerely, and genuinely interested in preserving the environment, it should not stop purchasing corporation A’s product X and buy corporation B’s product X: in fact, it must purchase MORE of corporation A’s product X and LESS of corporation B’s product X.

By doing so, the pubic sends a strong signal to corporations that it intends to put its money where its values are. It must show the corporations that it is a financially sound, if not profitable, decision to act in a socially responsible manner. This does not violate Friedman’s fundamental tenet that a corporation’s fundamental obligation is to maximize shareholder wealth because it is in the interest of corporations to act ethically because acting ethically is the means to maximize shareholder wealth.

To make this option viable however, we must redistribute obligations such that it is up to BOTH consumers and corporations to do the right thing. In fact, the burden on consumers is made greater in this case, because they are the ones that have to create significant demand for corporations to act ethically, and this means, above all else, really voting with their wallets.

But ask yourself this: how many people do you know are actually willing to act on their values? And no, drinking organic fair trade coffee does not count because it is not significant. So you are willing to pay that extra 50 cents or a dollar for fair trade coffee, but are you willing to spend an additional $100 on a product that you know to be made by a socially responsible corporation in an ethical manner? What is the upper limit of the price differential that you are willing to pay?

Furthermore, in order for this option to be truly viable, the incentive structure would have to hold across the entire globe. This is the essential prisoner’s dilemma problem: so long as one player cheats and benefits, the entire system collapses.

Hard? Of course, as it is nearly impossible to put in practice. But at least it is a theoretical answer to how corporations can both do well and do good. But this answer has radical implications for consumer behavior, and I heartily acknowledge that my present model is way over-simplified, but assuming ideal conditions, it could work.

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